Although markets have generally recovered from 2001’s abysmal performance, companies are still regularly giving out bad news in the form of profit warnings. The UK technology industry has been especially susceptible, with profit warnings from this sector tripling in the first three months of this year according to Ernst & Young. The sector is also issuing the highest number of profit warnings, with 14 percent of UK tech companies disclosing this news in the first quarter of 2006.
The concern for IR is how best to handle this negative news. Richard Davies of London-based IR consultancy RD:IR is sympathetic to the IRO’s admittedly exposed position when it comes to dishing out difficult material facts. ‘IROs aren’t in control of finance, but they are in control of financial reporting, so they’re caught between what they can report and what they are expected to report,’ says Davies. ‘At the same time, you can have a lousy business and a great IRO.’
Davies says IROs should try to steer away from a black/white or good/bad news model and instead focus on explaining effective risk management to investors before hitting black ice. ‘Risk management is an intrinsic part of the IRO’s job,’ explains Davies. ‘It’s foundational, and fund managers are increasingly looking to hear from management about how risk is managed. If you’re upfront about risks to contracts, for instance, you protect yourself against major share price volatility.’
Prone to bad news
IROs working in the tech sector need to hone their skills for profit warnings as this market is particularly vulnerable to this type of announcement. James Bennet, technology director at Ernst & Young, says a mixture of contract delays and an increasingly fickle client base is driving the current profit warning phenomenon among UK tech companies. ‘The main reason cited for these problems is a delay in contracts and projects,’ he notes. ‘It’s taking longer than expected for companies to sign contracts, and for smaller companies dependent on fewer big deals, this is an issue.
‘Customers are also becoming tougher and more sophisticated purchasers,’ adds Bennet. ‘They’re putting suppliers under pressure by negotiating slowly and demanding a last-minute change in price to coincide with the end of a significant accounting period for the supplier.’
‘Many contracts in the tech sector are now large, one-off deals, so if it’s big and something goes wrong, it’s very bad news,’ adds Bear Stearns analyst Jonathan Dann.lsquo;You’ve also got two types of tech consumers: business and retail. In the retail market we’ve had three years of a bull market with broadband and mobile phone penetration – broadband is now in 40 percent of UK homes. So it’s a much more mature market than in 2002.’ A matured market is a negative sign as high multiples are premised on strong future growth.
Be a skeptic
IROs working in this sector will continue to feel pressure to warn ahead if analyst estimates are to be missed. ‘Investor relations professionals in the small-cap sector in particular have to make a Faustian pact with analysts, for example, because the reality is that their companies have limited visibility,’ says Mark Klamer, a lawyer with St Louis-based Bryan Cave. ‘There’s this immense pressure to give a lot of guidance, but this can all too easily be upset because of sales lumpiness – just one or two contracts can make or break a quarter.’
IR needs to be a bit skeptical of the numbers coming out of the finance department, says Reg Hoare of London-based communications firm Smithfield. ‘You have to be absolutely on top of all the trading news,’ he says. ‘If you’re an experienced and savvy IRO, then one of the first things you must ask the finance department is, Are you sure? What about the budgets? Are they realistic?
‘Analysts and investors always want more info and detail, so you should resist any temptation to keep the bad news short and sweet,’ adds Hoare. ‘And you must make sure that when your statement comes out, you’re focusing not just on the bad news but also on what you’re doing about it. It helps if you have plenty of forward commentary to go with it.’
Keep the lines open
Access to management is another consideration. Analysts, financial journalists and investors often want to see management face to face so they can pick up on body language. Sometimes a webcast conference call with a Q&A session is sufficient. ‘This is certainly more effective than a terse press release with no follow-up,’ says Brian Bushee, assistant professor of accounting at the Wharton School of Business. ‘It’s about uncertainty. A conference call does let key investors and analysts dig deeper into the sources and implications of a profit warning than a press release can ever hope to do.’
Failure to answer questions on profit warnings can further depress stock price, adds Bushee. While no manager wants to face a crowd of unsettled analysts and investors, it’s best to deal with their queries in an upfront manner.
The ideal way to handle a profit warning is not to wait for the bad news to hit before establishing clear, consistent communications with analysts and investors. The IR role is aided by regular news flow in good times and bad, says Peter Bradley of law firm Stephenson Harwood. ‘The London Aim market is particularly price-sensitive and a lot of these companies don’t make sufficient use of financial PR, so the share price can languish because there’s little news about the company,’ he explains. ‘Clever use of financial PR can help active trading in a stock and prevent people from complaining about a lack of liquidity. The key here is telling your story, rather than repeating market noise or what other people think.’
‘Sometimes there is too much focus from companies on quarter-toquarter results,’ says Neil Matthews, a lawyer with London-based Eversheds. ‘Effective communication is not just about having lunch a few times a year with analysts and journalists. It’s about the bigger picture.’
